By Jason Simpkins
The Organization for Economic Cooperation and Development (OECD) raised its growth outlook for industrialized countries for the first time in two years and said the United States would experience a quicker recovery than Europe. However, the group also said that central banks around the world should maintain exceptionally low interest rates with little regard for inflation over the next two years.
After predicting a 0.1% economic contraction for its 30 member nations in March, the OECD said growth would reach 0.7% in 2010. The OECD also said this year's economic contraction would be 4.1% compared to its earlier forecast of a 4.3% decline.
"The good news is that economic activity in OECD countries is reaching bottom, following the deepest decline since the Second World War. In fact, this is the first Economic Outlook in two years to revise up previous projections for OECD economic growth compared with the previous Outlook." said OECD Secretary General Angel Gurria. "But we should not get carried away. The upward revision is fairly modest and we foresee a recovery that will be rather slow and fragile for some time."
The recovery in the United States is expected to outpace that of both Europe and Japan, according to OECD estimates. Gross domestic product (GDP) in the United States will contract 2.8% this year before rebounding to 0.9% growth in 2010. In March, the OECD predicted the U.S. economy would contract by 4% this year and stagnate in 2010.
Euro area GDP is expected to contract 4.8% this year and to be flat in 2010, the OECD said. That's actually worse than the organization predicted in March when it said the euro area economy would decline 4.1% this year and increase 0.3% in 2010.
"Signs of impending recovery in the euro area are not yet as clearly visible, reflecting country-specific combinations of bursting housing bubbles, export set-backs and damage to financial sectors," the OECD said. "The eventual recovery may also be slow in this region, including because rising unemployment makes consumers more reluctant to spend."
Analysts have said that the European Central Bank (ECB) erred by not cutting its lending rates as quickly and dramatically as the U.S. Federal Reserve, which could explain the difference between the rates of recovery for each region.
Other central banks "have their own responsibility and decisions and I have already said that as far as we are concerned, we would be very, very keen to avoid to be put in a situation which for us would not be appropriate, namely a liquidity trap," ECB President Jean-Claude Trichet said following the Fed's decision to cut its benchmark rate to a range of 0%-0.25%.
But it is precisely the aggressive monetary actions taken by the Fed and other central banks that the OECD credits with stifling the global recession.
"Signs have multiplied that U.S. activity could bottom out in the course of the second half of this year," said the OECD. "Such a recovery would reflect tremendous policy effort."
However, the group also warned that as fiscal stimulus fades and the need for balance-sheet repairs escalates, any U.S. recovery could be "uncharacteristically weak and insufficient to bear down on unemployment at around 10% of the labor force."
For that reason, the OECD recommends the U.S. Federal Reserve not raise rates until 2011. With regard as to whether or not keeping rates so low for such a long period of time will lead to inflation, the OECD doesn't see that as being the case.
"The projection that we have is one where the U.S. is emerging from the recession a little earlier than the euro area, which does not really support that argument," OECD chief economiest Jorgen Elmeskov told Reuters.
As far as Europe is concerned, the ECB – which has cut its benchmark rate to 1% –should exhaust "the remaining scope for cutting the rate on the main refinancing operations sooner rather than later."
"The bleak growth outlook argues for using additional room, where it still exists, for interest rates cuts and warrants keeping exceptionally low policy rates for a substantial period of time," the group said.
While policymakers at the ECB have recently expressed a willingness to push the key rate down below the 1% floor, there is still a measure of hesitancy on the continent.
The ECB yesterday (Tuesday) pumped a record 442.2 billion euros into the Eurozone banking system in its first-ever offer of unlimited one-year funds. The demand for the funds highlighted expectations in Europe that liquidity will not be available again on such favorable terms.
The ECB itself reserved the right in future one-year operations to charge an interest rate above its main policy rate.
"Let's wait and see how the latest measures work," Jose Manuel Gonzalez-Paramo, an ECB executive board member told the Financial Times. "We did not decide that 1% was the lowest level imaginable in any scenario, but we do think that it is the appropriate level given the information that we have currently available."
The preliminary Markit purchasing managers index (PMI), a closely watched survey released Tuesday, showed that Eurozone output fell for the thirteenth consecutive month in June.
The PMI rose to 44.4 in June, up from 44.0 in May. A reading of less than 50 indicates a contraction in activity, while a figure of more than 50 signals expansion. Economists had forecast a rise to 45.5, according to MarketWatch.com.
Dominic Bryant at BNP Paribas told The FT that Europe's economy won't be gaining traction "anytime soon," and he expects the economy to be "more or less flat for the next four quarters."
Europe's underperformance when compared with the United States and United Kingdom will reflect "the less aggressive action of policy makers in the Eurozone in the areas of monetary policy, fiscal policy and banking sector support," Bryant said.
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